Egypt Independent

Sukuk law in state of flux until Al-Azhar review

approved in late March a law allowing the issuance of sukuk, or Islamic bonds, which the heavily indebted government touts as a financial tool that can support the ailing economy.

Despite creating a stir for what some claim is essentially allowing vital state assets to be rented or mortgaged by foreigners, as well as drawing criticism from Al-Azhar for being non-compliant with Sharia, the law was pushed through by the Shura Council and is now pending ratification by President Mohamed Morsy.

But seemingly succumbing to mounting pressure from Al-Azhar’s Council of Senior Scholars demanding to review the law before it passes, Morsy referred the law to the council Sunday, and the scholars are set to meet next week to discuss this latest draft after the institution’s Jurisprudence and Legal Research Committee meets to discuss it as well.

The developments come after months of Al-Azhar’s rejection of the draft law, and unrelenting demands to review what they deem as an un-Islamic financial instrument. Al-Azhar have also criticized the law for giving Morsy the power to form an authority regulating the bonds.

According to Article 4 of the Constitution, the Council of Senior Scholars must weigh in on all matters concerning Sharia, but the article does not stipulate whether the council’s opinions are binding or consultative, which may mean that the back-and-forth debate over the law is far from over.

For their part, officials describe sukuk as a direly needed financial tool that can help the government in plugging its gaping budget deficit and provide funding for the cash-strapped economy. They point to its success elsewhere, including Gulf and European countries, as well as its resilience during the global financial crisis.

Finance Minister Al-Morsy Hegazy said last month that Egypt could raise about US$10 billion a year from the sukuk market, but added that it would take at least three months to push through the necessary regulations, Reuters reported.

Egypt is facing an amalgamation of financial crises in the form of dwindling foreign reserves, a dollar shortage coupled with a currency devaluation, meager capital inflows and poor tourism, as well as a deteriorating infrastructure.

The drive behind sukuk is the aim of attracting capital from previously untapped sources, in an attempt to close a budget deficit slated to reach LE200 billion by the end of 2013. Officials have repeatedly attempted to quell fears over the law saying that it does not allow foreign ownership of state assets or companies.

Al-Azhar’s Islamic Research Academy rejected the first draft of the law in January, saying it violates Sharia and “endangers the state’s sovereignty.”

Investment trumps consensus?

A seminar held last week discussing the sukuk law, hosted by the Rifa’a Al Tahtawi Forum for Democracy and Human Rights, highlighted the lingering divisions among politicians and experts.

Even if the new law manages to address the main areas of contention among Al-Azhar scholars, critics say it does not close the door on potential corruption and its potential manipulation to privatize public assets. But this may do little to stop the momentum.

Egypt’s 1992 capital market law already allows the sale of Islamic bonds, which enable holders to have shares in commercial, industrial and agricultural undertakings under a Sharia-friendly investment structure. However, Islamic finance was not promoted by the former regime even as it gained popularity globally.

Given that the international sukuk market is expected to reach $3 trillion by 2015, with 63 percent of the issuance in Malaysia and 32 percent in Arab Gulf area, it is easy to argue that it’s high time Egypt take advantage of the investment tool.

The broad variety of Islamic bonds can be compared to the range of Western investment instruments, from equity stocks to debt bonds. The main distinction lies in the fact that the sukuk owner does not own a share of the issuing entity but is considered as a partner on a specific project of the issuer.

In turn, investors share the profits and risks of what are usually mega-scale projects, according to a predetermined agreement.

During the seminar, Hamdy Abdel Azim, an economics professor at Sadat Academy, expressed optimism that sukuk would provide a quick boost for Egypt’s economy.

“Jeddah’s Islamic Bank offered to buy $6 billion worth of Egyptian sukuk, while Qatar said it will buy $3 billion,” he said.

If these transactions succeed, sukuk may attract about $15 billion worth of investments in the first year, he added.

The first batch of issuances will be government sukuk, he says, expecting the private sector to follow suit after assessing the potential of this new instrument.

Sukuk will also be utilized to finance a string of upcoming public-private partnership projects, said Finance Ministry adviser Ahmed al-Naggar, during the PPP Investment Summit held in Cairo in March.

Al-Azhar’s concerns

Abdel Azim affirmed that Al-Azhar’s comments and reservations were taken into consideration before the bill was approved, adding that sukuk would not be used in speculation, derivatives or futures contracts. Nor will it be used to finance the budget deficit directly, but will instead fund new profitable projects.

“The sukuk law does not allow selling, mortgaging or privatizing state-owned properties, which was Al-Azhar’s main concern,” he said.

Mohamed al-Beltagy, president of the Egyptian Islamic Finance Association, supports this claim by explaining that the term “Islamic” was removed from the official label of sukuk and that the validity period of the bonds was decreased from 60 to 12 years.

Yousri Ezdawy, a political researcher at Al-Ahram Center for Political and Strategic Studies, argues the Shura Council had the right to bypass Al-Azhar scholars since the term Islamic was removed from the description.

“Sukuk are no longer considered a religious matter and so it is not obligatory constitutionally to refer the law to Al-Azhar,” Ezdawy says.

Ezdawy believes the Muslim Brotherhood-dominated Shura Council attempted to avoid Al-Azhar out of fear that the institution would again overrule it. Despite this, Morsy has decided to let Al-Azhar scholars weigh in on the draft law before he ratifies it.

Member of the Shura Council Ayman Haiba claims that a much broader issue is at stake.

“We didn’t want to present it to the Senior Scholars so as to not set a precedent where every law issued by the [Shura] Council has to be presented to them for approval. After all, we are not in a religious state,” he argues.

While raising questions over Al-Azhar’s role as prescribed in the new constitution, Morsy’s move to refer the law to its scholars is perceived as an attempt to stem a confrontation between the Brotherhood and the highest seat of Sunni learning, as well as the Nour Party.

Nour Party head Younis Makhyoun criticized the Shura Council for passing the draft law to the president without first presenting it to Al-Azhar. The party also believes Al-Azhar’s should approve the long-awaited $4.8 billion loan from the International Monetary Fund since it carries an interest rate.

The suspicious rush

On the other hand, many experts deplored the rushed passage of the new law.

“There are serious reservations and concerns regarding the law. The most obvious is the rush in approving it without further deliberation,” says Salah Gouda, economist and head of the Economics Studies Center.

“With all respect to the Shura Council, why can’t the sukuk law, and the other law issued in a hurry, wait for the election of the [House of Representatives]?” he asks.

While Beltagy counters this argument, saying it was discussed for four days, he adds that sukuk, like any investment tool, requires “a strong plan from the government and political stability.”

Experts have long warned that for the new investment tool to translate into a flush of financing, it requires the same factors that would bring back foreign direct investment and overall economic recovery: political stability, proper administrative management and a clear economic plan built on consensus — all of which are missing.

Both Haiba and Gouda alluded to the fact that scrambling to pass the law may be a symptom of the government’s desire to implement rules more favorable to its faction.

“It all comes down to what is in the best interest of the group, not that of the nation,” says Haiba, hinting at the dominant Brotherhood.

The fate of public assets

Gouda made a strong case against the law, first by stating that “the sukuk law does not clarify who has the right to own sukuk. It could be Egyptians or foreigners.”

Former Grand Mufti Nasr Farid Wasel previously told Al-Masry Al-Youm that the bill would allow foreigners to own sukuk and shares in local factories and businesses: “It is like we are selling our properties to foreigners.”

Gouda adds that the ability to trace those who own the sukuk remains weak, which may eventually lead to the government’s not knowing who the sukuk holders and how much they own. He further denounces the weak controls over sukuk issuers, which may open the door to corruption. Tax exemptions, he claims, also give sukuk an unfair advantage over other financial products.

Most importantly, Gouda warns that the law does not specify how to settle cases in which the issuer fails to repay their financial obligations to sukuk holders, describing it as “another form of privatization.”

Like many of the law’s critics, he says it allows for the mortgaging of state assets and infrastructure to guarantee the dues and payments for sukuk holders, with no specific protection of public assets. If the project fails, he says, nothing would deter sukuk holders from seizing mortgaged assets.

“We are facing a major national security breach here,” he says.

Beltagy, who contributed to drafting the law, vehemently disagrees: “In case a project fails, the sukuk holder … would be compensated by a new sukuk on another project.”

The law looks even more ambiguous for not clearly distinguishing between, for example, a public textile company and a strategic asset. Each project will determine how sukuk holders may be indemnified.

Until then, controversy over the law, like many divisive decisions taken over the past two years, will likely linger as its consequences play out.